Only one type of person complains about paying taxes, one with a heartbeat. We all recognize the importance of taxes, but Gerald Barzan said it best, “Taxation with representation ain’t so hot either.” Yes, tax evasion is illegal; but tax avoidance…that’s wisdom. Legally reducing tax liability should be a financial advisor’s specialty. This is why I’m so surprised by the number of financial and tax professionals who are unfamiliar with or do not utilize Qualified Charitable Distributions.
The Qualified Charitable Distribution, or QCD, is a powerful tax savings strategy available to individuals age 70.5 and older who donate to 501(c)(3) organizations. Examples of 501(c)(3) organizations include churches, schools, scientific organizations, and private foundations.
When you take a distribution from a tax-deferred retirement account, the distribution will be taxed at your marginal tax rate. However, if the distribution is from an Individual Retirement Account (IRA) and is sent directly to a 501(c)(3) organization, it qualifies as a QCD and becomes completely tax-free.
For example, Elliott has a required minimum distribution from her IRA of $10,000. Her tax rate is 22% federal and 5% state. Elliott plans to donate $10,000 to a 501(c)(3) organization this year. If Elliott takes the $10,000 distribution, she will pay the tax and receive $7,300. When she makes her $10,000 donation, she will be $2,700 short.
However, Elliott has a wise financial advisor who tells her about the QCD. So, she sends her $10,000 distribution directly to the charity, and Elliott doesn’t pay tax on the distribution at all. Elliott’s required minimum distribution is satisfied for the year, she donated the desired $10,000 to charity, and her financial advisor saved her $2,700.
If you are claiming the standard deduction on your tax return, any donations to charities outside of a QCD will not lower tax liability. A QCD essentially allows you to “double dip” in tax savings. If you itemize your deductions, you may only be receiving a partial deduction for your charitable gifting. A QCD could provide a greater tax advantage.
It is important to understand that dollars donated via QCD above the annual Required Minimum Distribution (RMD) amount may not provide the same benefit. It’s best to consult with a financial professional to help design a distribution plan that best meets your specific needs.
A QCD is only available to those with a taxable IRA. If you have a 401(k), 403b, or any other tax-deferred retirement account, speak with us directly. We may have a solution that will allow you to take advantage of this valuable strategy.
Every year, we educate financial and tax professionals regarding the QCD and how to report it. Too often, we see it reported incorrectly. You won’t receive the benefit if you make a QCD and do not report it properly. In this example, if Elliott or her CPA doesn’t understand how to report the QCD, she will needlessly pay the $2,700 in tax.
If you, your CPA, or your friends have questions about QCDs or how to report them properly, please contact us. Tax planning is our specialty, and maximum tax savings is our goal.
Listen to a deep dive into QCDs on the Power Up Wealth podcast.
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